A longtime VC on the virtues of not swinging for the fences

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There’s a winner-take-all mentality in Silicon Valley. Unfortunately, it has distorted the thinking of countless entrepreneurs who’d likely be better off running smaller companies — and giving up less ownership to investors in the process. While funding announcements are widely celebrated as milestones, the reality is that founders often wind up with far less than their investors, and in plenty of cases, they can sell a company and make almost no money at all.

It’s a point that longtime VC Jodi Sherman Jahic was eager to make recently when we met up for coffee in San Francisco. In fact, Jahic — who cofounded the venture firm Aligned Partners with Susan Mason (who previously spent 15 years with Onset Ventures) — focuses exclusively on enterprise companies that are ruthlessly focused on capital efficiency and whose founders will turn away bigger checks, knowing they could be shooting themselves in the foot otherwise.

More from our chat follows, edited for length.

TC: You were a Kauffman Fellow, then spent something like seven years as a principal at Voyager Capital. Why start your own firm?

JJ: At the time, we were managing a $200 million fund, and [by 2007, 2008] I started to think that even that might be too much for some companies. With $200 million, you’re probably investing in 20 companies, committing up to $10 million in each, and at that level of risk, you’re likely to syndicate each deal. So, if every company can’t take at least $20 million and usually quite a bit more, then it’s probably not that interesting [to the $200 million fund]. And the problem gets larger as the fund gets larger.

TC: Did you see that a lot?

JJ: Absolutely. When a company is doing just fine, everyone wants to put their money into it, which is ironic because it only generates less cash-on-cash returns for everyone. Also, the venture world tells us this story that one-third of venture-backed companies will become an abject loss and one-third will go sideways and one-third will be hits. So founders reason that two-thirds of the time, they’ll be fine. But that’s not what happens. The majority of the time — something like 75 percent of the time, according to [the benchmarking company] Sand Hill Econometrics — founders who take venture money get not a dime. And the venture industry has made it worse by taking some opportunities that could be more efficient and generate returns for everybody and turning them into lets-swing-for-the-fences types of things. And not every company is going to grow up to be that.

People don’t realize this, but there is zero correlation between how much money goes into a company and its exit value.

TC: You struck out on your own years ago, when it was even harder for a woman to form a venture fund than today. How did you get things rolling?

JJ: I started with a pledge fund, with investors who’d invested alongside me in a wireless company that I’d backed in 2000. The company raised just $1 million but wound up producing a 7x return for us, so these investors committed a certain amount of capital and pledged that money on deal-by-deal basis.

To be honest, I’d just had my second kid. I wasn’t sure about fundraising. But this pledge fund idea turned out spectacularly. We invested in a total of seven companies, including AirLink Communications and Purple Wave Auction and almost all have exited or are cash-flow even and doing really well. We had just one loss.

TC: As you and Susan were forming your firm in 2011, the micro VC scene was beginning to explode. How has all that competition impacted your work?

JJ: I don’t see those firms as direct competitors.

TC: But you raised a $30 million debut fund in 2012, and a $50 million fund last year. Doesn’t that pit you directly against a lot of other firms that have raised similar amounts?

JJ: Most seed-stage funds spread their capital pretty thinly, making $500,000 bets on a large number of companies. I think it’s probably standard to invest in 20 to 30 companies. We don’t do that. We invest in $2 million to $5 million over the life of a company, we always take a board seat, and we lead. We feel like you need to do these things if you want to direct the course of an investment.

TC: So you’re competing with Series A investors. That sounds even harder, given that many have giant funds that they are investing across stages.

JJ: Actually, as you know, the late-stage market has been supported by an enormous amount of non-venture dollars, and as we’re seeing some of that money flee, we’re also seeing some the larger multi-stage firms focus on their high-burn portfolio companies and less on funding Series A and B companies.

TC: What do you need to see in terms of metrics?

JJ: A company has to have initial customers who we can call and understand why they bought. That’s usually less than a million dollars in total revenue when we come in.

TC: And what are you looking for in a team?

JJ: Capital efficiency is our core thesis. These are companies in the enterprise space that, by virtue of their go-to-market strategies, are unlikely to need more than $10 million. Also, our typical founder has started a few companies before. In fact, maybe [he or she] has sold a company for a substantial exit but got a nice lucite trophy and a thank you note but didn’t get wealthy because of their company’s cap structure. Those are the people who come to us, saying, “I want to do it differently this time; I don’t want to overstuff my company with excess capital.”

TC: You were working as a VC back in 2000, when the last bubble burst. Do you agree with a lot of other investors who think that despite these go-go times, things are different?

JJ. I do. I think we’re seeing many higher-quality companies than we did then. Many fewer venture-backed companies have gone public, too, and on the private market, it takes time for pricing to fall, whereas when you’re public and the market falls out, people leave in droves. So I don’t think we’ll see a bubble popping like we did in 2000 and 2001.

Still, I think that because of the vividness of unicorns and exits like that of WhatsApp, a lot of founders and investors overestimate the likelihood of a big exit.

I push back on a lot of that power law stuff; it can be an excuse for bad behavior and stupid valuations. If you have to hit outliers to make your nut, you have to do crazy things. If we set things up to see achievable exits, everybody will do better.